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Homebuilders Getting the Shingles?

Interest rate jitters shave their shares.

Shares of publicly traded homebuilders have fallen hard this week based on concerns that interest rates may have bottomed out and increases ahead could shrink the market for new homes. Yet most report bigger order backlogs -- luxury builder Toll Brothers(NYSE:TOL) brags a 41% year-over-year increase -- and the group keeps grabbing market share from privately held competitors.

A few days of declines hardly dent market-crushing returns. Several years of falling mortgage rates made new homes more affordable for millions of Americans and boosted homebuilding stocks throughout 2002. But even after rising while the rest of the market was collapsing to year-ago October lows, the shares offered fabulous gains the next 14 months, led by William Lyon Homes(NYSE:WLS), Hovnanian Enterprises (NYSE HOV), Ryland Homes(NYSE:RYL), D.R. Horton(NYSE:DHI), and Pulte Homes(NYSE:PHM).

Yup, that's right. While stocks fell all last year, homebuilders topped Investor's Business Daily's relative strength ratings (enjoy a free trial from our business partner today). Relative strength (RS) is a measure of stock price gains. Choosing a given period (a year, a quarter, etc.), an RS of 99 means that the stock's price performance beat 99% of stocks in the reference group (for example, all stocks listed on the three major exchanges/markets). An RS of 30 would mean that 70% of the reference group outperformed.

One of our analysts saw the industry's RS and decided to track the performance from that day -- Sept. 12, 2002. These high RS stocks just kept on going:

Top Homebuilders' Price Change Since 9/12/02

Company

P/E

Gain

William Lyon Homes

10.8

166%

Hovnanian

11.3

127%

Ryland

10.5

101%

D.R. Horton

10.3

89%

Pulte Homes

10.4

85%

Standard Pacific(NYSE:SPF)

8.9

69%

Lennar(NYSE:LEN)

10.1

66%

Tech Olympic USA(NASDAQ:TOUS)

9.2

64%

MDC Holdings(NYSE:MDC)

10.1

63%

Meritage(NYSE:MTH)

10.2

59%

Toll Brothers

12.5

51%

Nasdaq Composite

49%

NVR Homes(AMEX:NVR)

11.2

48%

Beazer(NYSE:BZH)

7.9

43%

Centex(NYSE:CTX)

9.8

43%

KB Home(NYSE:KBH)

8.2

33%

S&P 500

22%

WCI

10.0

11%

MHO

7.7

3%

Great. But where to now? Are interest rates a threat?

Not according to sell-side analysts. They have hyped the stocks relentlessly, trolling for business while proclaiming a paradigm shift that historic P/E ranges for the companies -- single digits to 10 -- no longer matter because the businesses are no longer cyclical. Hmm. We are always nervous when we hear that the economics of a business has somehow changed permanently, because it reminds us too much of the new economy talk of 1929 and 1999. And no matter what, it's no excuse to avoid analyzing individual companies and noting the management issues at a company like NVR.

It's anybody's guess where interest rates will go, but it's a safe bet they won't go lower. At some point, the federal government's budget deficit will bring pressure to raise rates to attract capital to finance the debt, or economic recovery will lead to inflationary pressures and higher rates. This would likely balance the positive effects of increasing population and market share. Thus, it's probably true that these stocks' best days are over, but it doesn't rule out more sunshine for a while longer.

It's out!Get your copy of Stocks 2004, our analysts' best picks for the year ahead!